Dueling Pricing Strategies

The world of retail price promotion has split into two distinct blocs. While everyday low pricing (EDLP) has vaulted some companies to the top of their sector, the use of promotional pricing (for example, discounts, regular specials and one-time clearance sales) has also intensified. Seasonal markdowns arrive earlier each year, and the amount of marked-down merchandise has seen double-digit increases. Promotional tactics — from coupons and direct-mail offers to e-mail invitations to sales and sweeter loyalty rewards — have proliferated.

Meanwhile, retailers seek to determine if the dollars pouring from their promotion budgets are paying dividends or merely eroding already tight margins. Longtime heavy price promoters wonder if a shift to EDLP will hone their competitive edge. Or, if they stick with promotional tactics, they must decide what proportion of their prices should be promotional, how deeply should they discount, and whether they should advertise both sale prices and everyday prices. Retailers struggle to address such problems with little information about how price-promotion strategy affects sales volume and how competitors will respond.

A new study, “When Does Retail Price Promotion Make Sense?” presents a framework to help retailers evaluate, fine-tune and even radically shift their approaches to price promotion. The authors, Kathleen Seiders, associate professor of marketing at Babson College and Glenn B. Voss, associate professor of business management at North Carolina State University, examine the pricing and promotion strategies of 38 U.S. retailers in 11 retail sectors representing key national competitors (for example, Circuit City and Best Buy in consumer electronics, Kmart and Wal-Mart in the discount-store sector, and Lowe's and The Home Depot in home improvement). On the basis of their analysis of advertisements placed during a five-quarter period, the researchers scored each retailer's price-promotion strategy on three dimensions: price-variation policy (ranging from “everyday pricing with no variation” to “promotional pricing with frequent variations”), price-promotion volume (amount of advertising dedicated to communicating a price promotion) and depth of discount (average magnitude of discount offered on featured sale items). The authors then used the three scores for each company to calculate each sector's overall promotional intensity index.

Next, they rated each sector on two criteria: assortment overlap (how closely retailers' product assortments resemble one another) and assortment lifespan (how quickly a typical assortment loses value or becomes obsolete). In the authors' view, the effectiveness of a retailer's price-promotion strategy hinges on how well that strategy aligns with these two criteria. To demonstrate their thinking, Seiders and Voss created a four-cell matrix in which one dimension comprises low-to-high assortment overlap and the other, low-to-high assortment lifespan. Each of the four cells suggests a different approach to retail price promotion:

In the low lifespan/low overlap and high lifespan/high overlap categories, the authors argue that retailers can achieve the most success by following everyday high or low pricing strategies. For example, high-end fashion department stores and specialty stores — in the low lifespan/low overlap category — rely heavily on unique and innovative products for differentiation, while facing pressure to move short-lived products. They use everyday high pricing to reinforce their cachet, and because of higher original margins, they can afford occasional deep discounts to build store traffic without damaging their image and price credibility. Meanwhile, large, efficient chains — in the high overlap/high lifespan category — depend on everyday low pricing to garner volume sales, seeking economies of scale or scope to lower expenses in order to support prices

Retailers in the high overlap/low lifespan and low overlap/high lifespan categories can benefit most from using promotional (rather than everyday high or low) pricing. For instance, consumer-electronics retailers and automobile dealers — in the high overlap/low lifespan group — must cope with ongoing product proliferation. They can deepen their assortments with numerous product modifications and use frequent price promotions to reach a wide range of customers and drive sales of soon-to-be-obsolete products. Furniture stores and fast-food companies — in the low overlap/high lifespan category — sell to customers who aren't fussy about their shopping destination and these retailers can use sales and coupons to encourage trial shopping and retain market share.

Some retailers — such as traditional department stores and supermarkets —are hybrids, characterized by moderate overlap and moderate lifespan. They offer many product categories — some commodity-like and others more prone to obsolescence — and in facing intense competition within and across sectors, these retailers use heavy promotional pricing (such as weekly circulars, coupons and in-store specials) to attract customers and control large, diverse inventories.

Seiders and Voss then studied the relationship between price promotion and retailers' financial performance for all sectors — finding a positive correlation between promotion and revenues and a negative one between promotion and profits. However, the strength of these relationships varies significantly across sectors. To illustrate, though the furniture, grocery and traditional department-store sectors all reap extensive performance benefits from price promotion, it's the most effective strategy in the grocery sector, while much less effective in the furniture-store sector (perhaps owing to low advertising volume, which may in turn stem from channel verticality).

Seiders and Voss suggest that a retailer can use this framework to determine its optimal price-promotion strategy. After identifying which matrix cell best defines its current position, the company can ascertain whether its current strategy (with regard to price variation, promotional advertising volume and discount depth) is consistent with the rest of its sector. By pinpointing and questioning the assumptions that underpin that strategy, the company will be better able to assess what, if any, strategic changes should be made.

For example, the department-store chain Dillard's decided to defy that sector's norm by moving toward an everyday pricing strategy, offsetting its low price variation by offering deeper discounts than its competitors. The company also developed a strong store brand franchise, raising revenue and boosting earnings through its higher margin, private-label merchandise. Dillard's experience suggests that a retailer adopting a price-promotion strategy contrary to its sector norms may need to modify its assortment overlap and lifespan conditions to reap the full benefits of its new approach.

For more information about the study, contact the authors at seiders@babson.edu and gvoss@ncsu.edu.